Tài chính doanh nghiệp - Chapter 13: Leverage and capital structure

13-1Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin13-2Key Concepts and SkillsUnderstand: The effect of financial leverage on cash flows and cost of equityThe impact of taxes and bankruptcy on capital structure choiceThe basic components of the bankruptcy process13-3Chapter Outline13.1 The Capital Structure Question13.2 The Effect of Financial Leverage13.3 Capital Structure and the Cost of Equity Capital13.4 Corporate Taxes and Capital Structure13.5 Bankruptcy Costs13.6 Optimal Capital Structure13.7 Observed Capital Structures13.8 A Quick Look at the Bankruptcy Process13-4Capital StructureCapital structure = percent of debt and equity used to fund the firm’s assets“Leverage” = use of debt in capital structureCapital restructuring = changing the amount of leverage without changing the firm’s assetsIncrease leverage by issuing debt and repurchasing outstanding sharesDecrease leverage by issuing new shares and retiring outstanding debt13-5Capital Structure & Shareholder WealthThe primary goal of financial managers:Maximize stockholder wealthMaximizing shareholder wealth =Maximizing firm valueMinimizing WACCObjective: Choose the capital structure that will minimize WACC and maximize stockholder wealth13-6“Financial leverage” = the use of debtLeverage amplifies the variation in both EPS and ROEWe will ignore the effect of taxes at this stageWhat happens to EPS and ROE when we issue debt and buy back shares of stock?The Effect of Financial Leverage13-7Trans Am Corporation Example13-8Trans Am CorpWith and Without Debt13-9Leverage EffectsVariability in ROECurrent: ROE ranges from 6.25% to 18.75%Proposed: ROE ranges from 2.50% to 27.50%Variability in EPSCurrent: EPS ranges from $1.25 to $3.75Proposed: EPS ranges from $0.50 to $5.50The variability in both ROE and EPS increases when financial leverage is increasedReturn to Quick Quiz13-10Example: Break-Even EBITEPS = for both Capital Structures13-11Break-Even EBITIf we expect EBIT to be greater than the break-even point, then leverage is beneficial to our stockholdersIf we expect EBIT to be less than the break-even point, then leverage is detrimental to our stockholders13-12Trans Am Corp ConclusionsThe effect of leverage depends on EBIT When EBIT is higher, leverage is beneficialUnder the “Expected” scenario, leverage increases ROE and EPSShareholders are exposed to more risk with more leverage ROE and EPS more sensitive to changes in EBIT13-13Example: Homemade Leverage & ROEConclusion:Any stockholder who prefers leverage can create their own “homemade” and replicate the payoffsTrans Am’s capital structure is irrelevant to shareholders13-14Capital Structure TheoryModigliani and Miller M&M Proposition I – The Pie ModelM&M Proposition II – WACCThe value of the firm is determined by the cash flows to the firm and the risk of the firm’s assetsChanging firm valueChange the risk of the cash flowsChange the cash flows13-15Capital Structure Theory Three Special CasesCase I – AssumptionsNo corporate or personal taxesNo bankruptcy costsCase II – AssumptionsCorporate taxes, but no personal taxesNo bankruptcy costsCase III – AssumptionsCorporate taxes, but no personal taxesBankruptcy costsReturn to Quick Quiz13-16Case I – Propositions I and IIProposition IThe value of the firm is NOT affected by changes in the capital structureThe cash flows of the firm do not change; therefore, value doesn’t changeProposition IIThe WACC of the firm is NOT affected by capital structure13-17Case I - EquationsWACC = RA = (E/V) x RE + (D/V) x RDRE = RA + (RA – RD) x (D/E)RA = the “cost” of the firm’s business risk (i.e., the risk of the firm’s assets)(RA – RD)(D/E) = the “cost” of the firm’s financial risk (i.e., the additional return required by stockholders to compensate for the risk of leverage)13-18M&M Propositions I & IIFigure 13.3The change in the capital structure weights (E/V and D/V) is exactly offset by the change in the cost of equity (RE), so the WACC stays the same.13-19Business and Financial RiskRE = RA + (RA – RD) x (D/E) Business Risk Financial Risk Proposition II: the systematic risk of the stock depends on:Systematic risk of the assets, RA, (business risk)Level of leverage, D/E, (financial risk)13-20Case II – Corporate TaxesInterest on debt is tax deductibleWhen a firm adds debt, it reduces taxes, all else equalThe reduction in taxes increases the cash flow of the firmThe reduction in taxes reduces net income13-21Case II - ExampleInterest Tax Shield = $24 per year13-22Interest Tax ShieldAnnual interest tax shieldTax rate times interest payment$1,000 in 8% debt = $80 in interest expenseAnnual tax shield = .30($80) = $24Present value of annual interest tax shieldAssume perpetual debt PV = $24 / .08 = $300PV = D(RD)(TC) / RD = D*TC = $1,000(.30) = $30013-23M&M Proposition I with TaxesFigure 13.413-24Case II – Graph of Proposition II13-25M&M SummaryTable 13.413-26Bankruptcy CostsDirect costsLegal and administrative costsEnron = $1 billion; WorldCom = $600 millionBondholders incur additional lossesDisincentive to debt financingFinancial distressSignificant problems meeting debt obligationsMost firms that experience financial distress do not ultimately file for bankruptcyReturn to Quick Quiz13-27Indirect Bankruptcy CostsIndirect bankruptcy costsLarger than direct costs, but more difficult to measure and estimateStockholders wish to avoid a formal bankruptcy Bondholders want to keep existing assets intact so they can at least receive that moneyAssets lose value as management spends time worrying about avoiding bankruptcy instead of running the businessLost sales, interrupted operations, and loss of valuable employees, low morale, inability to purchase goods on creditReturn to Quick Quiz13-28Case IIIWith Bankruptcy Costs D/E ratio → probability of bankruptcy probability → expected bankruptcy costsAt some point, the additional value of the interest tax shield will be offset by the expected bankruptcy costsAt this point, the value of the firm will start to decrease and the WACC will start to increase as more debt is added13-29Optimal Capital StructureFigure 13.513-30ConclusionsCase I – no taxes or bankruptcy costsNo optimal capital structureCase II – corporate taxes but no bankruptcy costsOptimal capital structure = 100% debtEach additional dollar of debt increases the cash flow of the firmCase III – corporate taxes and bankruptcy costsOptimal capital structure is part debt and part equityOccurs where the benefit from an additional dollar of debt is just offset by the increase in expected bankruptcy costs13-31The Capital Structure QuestionFigure 13.613-32Additional Managerial RecommendationsTaxesThe tax benefit is only important if the firm has a large tax liabilityHigher tax rate → greater incentive to use debtRisk of financial distressThe greater the risk of financial distress, the less debt will be optimal for the firmThe cost of financial distress varies across firms and industries13-33Observed Capital StructuresCapital structure differs by industriesDifferences according to Cost of Capital 2008 Yearbook by Ibbotson Associates, Inc.Lowest levels of debtComputers = 5.31%Drugs = 6.76% debtHighest levels of debtCable television = 61.84%Airlines = 56.30% debt13-34Example: Work the WebYou can find information about a company’s capital structure relative to its industry and sector using the industry center or sector analysis through Yahoo! FinanceClick on the Web surfer to go to the siteChoose a company and get a quotePerform sector and industry comparisons13-35Financial Distress DefinedBusiness failure – business terminated with a loss to creditorsLegal bankruptcy – petition filed in federal court for bankruptcyTechnical insolvency – firm unable to meet debt obligationsAccounting insolvency – book value of equity is negative13-36The Bankruptcy ProcessLiquidationChapter 7 of the Federal Bankruptcy Reform Act of 1978ProcessPetition filed in federal courtTrustee elected by creditors to take over firm’s assetsTrustee attempts to sell assetsProceeds distributed according to the absolute priority rule (APR)Return to Quick Quiz13-37The Bankruptcy ProcessReorganizationChapter 11 of the Federal Bankruptcy Reform Act of 1978Process:Petition filed by firm or creditorsUsually, firm continues operation as “debtor-in-possession”Firm submits reorganization planIf accepted by classes of creditors, then confirmed by courtFirm makes payments to creditors and operates under plan for some fixed timeReturn to Quick Quiz13-38Financial Management & BankruptcyThe right to file bankruptcy has strategic valueImmediate “stay” on creditorsAbility to terminate labor agreementsAbility to lay off large numbers of workersAbility to reduce wages“Workouts” and “Cram-downs”Pre-packaged filingsNegotiated filings and extensionsCourt-ordered plan acceptance13-39Quick QuizHow does financial leverage effect ROE and EPS? (Slide 13.9)What are the three capital structure cases? (Slide 13.15)What are the direct and indirect costs of bankruptcy? (Slides 13.26 and 13.27)What are the two chapters of bankruptcy and how do they differ? (Slides 13.36 & 13.37) Chapter 13END